Our economic numbers aren’t what they appear to be because of a phenomenon economist John Maynard Keynes called Money Illusion
After years of bad news caused mainly by outside events—the prolonged dispute over constitution, trade blockade, earthquake—the Nepali economy appears to find its footing, to chalk up reasonable growth. In the annual survey of the Ministry of Finance, prepared in conjunction with the new budget, the ministry states that the economy is expected to grow by 7 percent in the current fiscal, after dismal growth in 2015/16, which was attributed mainly to damages caused by April 2015 earthquake.
Looking back, the ministry states that per capita income has reached a record US $862, more than double the level eleven years ago in 2006/07. This means that annual income for everyone in the country—man, woman and child—reached Rs 88,268 this year, from just half this amount in 2006/07. To make sense of these numbers, per capita income data implies that a family of five earned Rs 37,000 a month, which is about the salary of a First Class Officer in the government.
However, there is a problem with these numbers as they do not mean what they are supposed to—that Nepalis today are twice as well off as they were a decade ago. To make such comparisons, we need to look at what economists call real value instead of face value of money.
This reminds me of a memorable statement by Alan Greenspan, former Chairman of US Federal Reserve, who is reputed to have said that central bankers are trained to take the punchbowl away, just when the party is warming up. In the present context, it appears that Nepal is averse to using real numbers, instead of using nominal figures, because it could potentially deflate the buoyant mood.
The point is that our money and earning numbers aren’t what they appear because of a phenomenon economist John Maynard Keynes characterized as Money Illusion. To find their real worth, you need to look at money in terms of its purchasing power: how much a fixed amount of money or income buys now compared to its purchasing power 10, 20, or 100 years ago.
Given this background, let us examine the doubling or tripling of GDP, as claimed by the Ministry of Finance. The per capita income of $862, in fact, is much less in real terms (adjusted for inflation).
To compare the per capita income in 2016/17 with per capita income in 2006/07, we need to use the change in CPI (Consumer Price Index) over these two periods, which gives a per capita income of US $505 for 2006/07, compared to $862 in 2016/17—an increase of 70 percent, much less than 100 percent shown by nominal values.
Looking at growth in real GDP over 11 years between 2006/07 and 2016/17, the finance ministry reports an average four percent annual growth for the economy which, after adjusting for population growth, yields just two percent growth in real per capita GDP annually over more than a decade, which is not something to celebrate.
Looking back over a much longer period, the economy seems to have been in doldrums or stationary with no growth in real per capita income. The evidence is the comparison of per capita incomes over 50 years, between mid-1960s to 2017. Nepal’s per capita income in mid-1960s was about $100, which increased to $733 by 2015, according to the IMF.
Using 5.5 percent real GDP growth in 2016/17, as projected by the IMF, and likely increase in the price levels, nominal GDP would then be about $800 for 2016/17, or eight times larger than $100 in the late 1960s.
During the same time period, CPI prices increased by about 7.5 times, more or less offsetting the eight-fold increase in nominal per capita GDP. In other words, over this period of 50 years, Nepal’s economy was stuck, without any growth in real per capita income. This also means that living conditions in the country haven’t changed over this period.
This then amounts to total discredit of government’s economic policies—during panchayat rule as well as during democratic dispensation—spanning over 50 years starting from the mid-1960s. The government has been making spurious claims all along that Nepali economy has been growing steadily and poverty is being reduced at a rapid clip. However, there is no evidence that development efforts have benefitted the larger society over at least three generations.
From all of the above accounts—inconsistencies and untruths—it appears that politicians and authorities either do not have a clue about economic growth and of how it comes about. In other words, in a largely subsistence- and barter-based economy, the government is facing measurement difficulties in the valuation of products and in understanding how GDP grows (or does not) over time.
Focusing on growth of GDP, it basically has two sources: increases in labor force and gains in labor productivity. Productivity measures how much output per unit of labor hour grows over time. Assuming 2 percent annual growth in labor force, productivity growth, on average, has been two percent per annum, for poor economies. One Indian economist joking characterizes such low growth in this part of the world as ‘Hindu rate of growth’. Nepal truly falls within this paradigm.
However, it may not be true that the Nepali economy has in fact been growing at 4 percent. Evidence is that actual growth may be no more than 2 percent for the total economy, most of it attributed to labor force growth. If true, per capita income growth in real terms has been about zero over a long period. There should then be serious concern on the part of policymakers to find out the reasons for low productivity growth of the Nepali economy.
Productivity defined as labor productivity has many sources, the most important of which, at least in countries at low levels of development, is the volume of capital investment in roads, railways, health care, education and research. These, over time, help labor become more productive.
For Nepal, the investment rate—portion of GDP invested in plant, equipment, skills development, and infrastructures—has been between 20 to 30 percent of GDP during the past 20-30 years, nearing 30 percent in most recent years. Theoretically, other things staying unchanged, this rate of investment can yield 6 to 7 percent GDP growth annually, as shown by the experience of many countries, including Nepal’s neighbors Bangladesh, Bhutan and India. For some unexplained reasons, however, Nepal has been an outlier, achieving just 3 to 4 percent growth and, using international data, no growth at all when measured growth is measured in terms of growth in real per capita income.
Leaving aside the bombastic and unrealistic claims of government presiding over an expanding economy yielding better living conditions for all, it should rather, in cooperation with the donor community, get to work in order to find out the reasons for such low growth. Intuitively, all our investment must be going somewhere, either being wasted or being used for personal enrichment.
The author teaches economics at NOVA College, Virginia